Bank of America analysts argue that Kevin Warsh - President Donald Trump’s pick to lead the Federal Reserve - would probably find it difficult to reduce the central bank’s large holdings of bonds unless such an effort coincided with a tightening of financial conditions.
Warsh has been an outspoken critic of the Fed’s bond purchase programs, saying those holdings can distort the broader financial picture and arguing in favor of a smaller balance sheet. The central bank’s asset pile swelled during crisis-response campaigns - including actions taken around the global financial crisis and the COVID-19 pandemic - before contracting from a peak of about $9 trillion in 2022 to roughly $6.6 trillion late last year.
However, the Fed began to expand the balance sheet again in December with the stated aim of ensuring sufficient liquidity so that interest rates remain near officials’ target range. It is not yet clear whether Warsh would seek to halt or reverse that resumption of growth.
In a research note, BofA strategists including Mark Cabana and Katie Craig said Warsh’s public criticisms of the Fed’s balance sheet do not guarantee he would be an effective architect of its reduction. The analysts wrote that they "suspect he would find it easier to be" a critic than to act as a "change agent."
The bank’s team said lowering the Fed’s holdings in size would likely require corresponding reductions in the central bank’s liabilities as well, possibly achieved through adjustments to bank liquidity guidance or regulatory changes. Without such liability reductions, they cautioned, an aggressive push to shrink the balance sheet could provoke funding dislocations, wider market turbulence, and tighter financial conditions.
"We suspect Warsh to favor easy fin[ancial] conditions over smaller Fed sheet, given difficulty of reducing Fed liabilities," the analysts said, suggesting that the nominee might opt to prioritize smoother financial conditions instead of pursuing rapid balance sheet contraction.
BofA also noted the political context, observing that President Trump would likely place more weight on the state of financial conditions than on the size of Fed reserves, and they said Warsh is "likely to side with Trump."
Warsh himself has acknowledged the practical challenges of shrinking the Fed’s balance sheet, pointing out that the balance sheet is a tool the central bank uses to help manage its target range for interest rates.
The debate over how and when to reduce the Fed’s asset holdings centers on the trade-offs between shrinking reserves and maintaining market stability. BofA’s view highlights a potential preference for preserving accommodative financial conditions over achieving a substantially smaller balance sheet unless structural changes to liabilities can be put in place first.